The parity condition of the covered interest rate is an important criterion for determining the forward exchange rate. It means that if Rh-Rf=F-S/S is established, there will be no international financial arbitrage activities between the two countries that cause cross-border capital flows; On the contrary, market behavior will correct the deviation between interest rate, spot interest rate and forward exchange rate until equilibrium is reached.
Compared with the uncovered interest rate parity, CIP does not assume investors' risk preference, that is, when arbitrageurs arbitrage, they can sign forward foreign exchange contracts (swaps) in the opposite direction of arbitrage in the forward foreign exchange market to determine the exchange rate level for delivery at maturity.
Definition and meaning of offset interest rate parity;
By signing a forward foreign exchange contract and trading at the forward exchange rate stipulated in the contract, the purpose of hedging can be achieved. Because arbitrageurs use the forward foreign exchange market to fix the exchange rate in future transactions, the influence of exchange rate risk is avoided, and the whole arbitrage process can be realized smoothly.
Meaning: The difference between domestic interest rate and foreign interest rate is equal to the forward discount (premium) of domestic currency. The currencies of countries with high interest rates must be discounted in the forward foreign exchange market, and the currencies of countries with low interest rates must be at a premium in this market. If the domestic interest rate is higher than the international interest rate, funds will flow into China to make a profit. When offsetting interest rate parity, arbitrageurs should not only consider interest rate returns, but also consider the changes in returns brought about by exchange rate changes.